APPLE MARGIN SQUEEZE: Global Telecoms Are Now Refusing To Pay Up For The iPhone

tim cook

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One of the big concerns about Apple’s stock going forward is the risk that the company’s extraordinarily high profit margin may drop as the company moves toward a less-profitable mix of products and the smartphone market enters a new growth phase.

Apple’s iPad, for example, has a significantly lower profit margin than the iPhone. And the iPad Mini, which is now presumably cannibalising some full-size iPad sales, likely has a lower margin (or at least lower contribution per unit) than the full-size iPad.

As Apple sells more iPads as a percentage of its overall product mix, therefore, its profit margin may decline.

Another potential hit to Apple’s margin may come from the iPhone, which is currently a spectacularly profitable product that accounts for most of Apple’s profits.

Since launching the iPhone in 2007, Apple has been able to maintain an average price point for the iPhone of over $600, thanks to the iPhone’s superiority to other smartphones, generous carrier subsidies in major markets, and consumers’ desire for the phone.

The smartphone market has entered a new growth phase, however, one in which price is a major issue for most new first-time smartphone users. Competitors have also caught up to Apple, and carriers in some countries are beginning to reduce their subsidies.

As a result of these and other factors, smartphones based on Google’s Android platform have vaulted past the iPhone in global market share, to the point where Android now controls ~75% of the global market to Apple’s 15%.

Apple profit margin
Apple’s profit margin… what goes up will now likely come down.

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The demand for lower-priced phones in China, India, and other emerging markets will continue, and this is where most of the growth in the market is likely to come over the next few years. If it wants to maintain its market share, therefore, Apple may be forced to produce a truly low-priced phone.Also, as other smartphone vendors like Samsung catch up with Apple, Apple is losing leverage with some wireless carriers.

The carrier subsidies in markets like the US and Europe have made the iPhone affordable for consumers and spectacularly profitable for Apple. In some markets, however, carriers are beginning to reduce or drop these subsidies, which makes iPhones more expensive for consumers.

And now some carriers appear to be pushing back on Apple’s onerous sales terms, refusing to distribute the iPhone unless Apple cuts its financial demands.

The leading carrier in Russia, for example, OAO Mobile Telesystems, does not yet have a contract to sell the iPhone 5, Ilya Khrennikov of Bloomberg reports.

OAO has sold all previous versions of the iPhone. But the carrier has decided that Apple’s demands are simply too high:

“Apple is seeking to pass on to operators not only the advertising costs in the country, but also logistics and repair costs,” said Denis Kuskov, head of St. Petersburg-based researcher Telecomdaily. “As a result, the operators either have to overprice the handsets or carry losses on these sales.”

Russia’s second-largest mobile carrier won’t be selling the iPhone 5, either. It hasn’t sold Apple devices since 2010.

And then there’s the biggest dog in the global wireless business: China Mobile.

Future Of Digital
Most of the world’s rich people already have a smartphone.

Wall Street has been waiting for Apple to sign a deal with China Mobile for years, drooling at the thought of the massive carrier selling iPhones to its 650+ million subscribers.The two companies have had talks, but as yet they have yet to reach a deal. And based on comments China Mobile CEO made last week, the hurdle is not just technology (China Mobile runs on a proprietary network):

“Besides the technical issues, the business model and benefit sharing still need further discussion,” CEO Li Yue said, Bloomberg reports.

The explosive growth in the smartphone market over the next few years is likely to come in China, India, and other emerging markets in which price is a significant issue for most phone-buyers. If Apple wants to participate in this growth, it is going to have to reduce lower-priced phones or reduce the other economic benefits it demands from its carrier partners (or both).

Apple isn’t in trouble, by any means. The recent decline in its stock has already “priced in” a margin decline to some extent. And Apple has enormous financial flexibility with which to reduce its profit margin to drive future growth.

But the days of continual increases in Apple’s profit margin driving spectacular earnings growth are likely coming to an end. If anything, over the next few years, Apple’s profits are likely to grow more slowly than revenue.

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